PARPCC #10 – The company rating system in China : effective measure to encourage entrepreneurial virtue ?

Panda, Rice Alcohol and PCC is a column of Camille Brugier, aimed at introducing scientific articles to a wider audience. His publications can be found on his thread Twitter.

Can we measure whether a company is financially reliable?, socially responsible and legally irreproachable? In the dream of Chinese leaders yes…in reality it is more complicated.

Yu-Hsin Lin and Milhauptz study here the creation in China of a social credit system for businesses (CSE) (Corporate social credit system), which should make it possible to assess their reliability. How does the CSE work and how to get well ranked there??

You hadn't heard too much about the CSE? It's normal, the press focused a lot on a parallel system of social credit to rate citizens. The initial objective is to compensate for a summary legal framework and to regulate the action of companies by “noting” them in line with Chinese “state capitalism”.. The CCP worked hard and formalized the CSE in 2014 (original public policy document here).

How does this rating system work?? More or less it needs to collect a lot of data on the behavior of companies – their compliance, the results of labor inspections, their payment history, their debt, etc. As is often the case in Chinese public policies, a large number of actors are involved: the ministers, the provinces, market regulatory agencies, the Central Bank; but also Chinese Big Tech like Huawei, Ali Baba, Tencent who helped Xi perfect the system to create a mega database: the National “Internet +Monitoring” System (National “Internet + Supervision” System)

Once noted, companies receive rewards…or punishments. We're not talking about stickers or point-scoring courses, but red and black lists.

The red list It's good. eh yes, red is a particular color in China. Listed companies have access to certain public markets, to more substantial financing/investments. The blacklist, elle,  triggers labor inspections, borrowing restrictions (this is also what has happened recently to many real estate developers).

Pour le Zhejiang, only province to have published assessment results to date, we retain that:

• 1/ more profitable companies are not better rated
• 2/ companies most exposed to markets are less well rated
• 3/ politically well-connected companies (those whose leaders have a function within the Party or in the government) are better rated.

Surprise? Not really. By digging into the scale, the authors show what we already knew about rankings – that they can be biased. Ici, in favor of the CCP…

From 5 criteria counting for the grade, alone 1, that of “social responsibility” concentrates the bad marks (3,8/10 on average). On the other criteria, companies have generally high scores -e.g. 9,9/10 on average on “basic information”. Put another way, to improve their grade, companies have room for this criterion, less on others. Or, to progress on social responsibility, you must make donations to organizations accredited by the Party, volunteer work, prizes won from the Party for their actions for society.

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With “Soviet” scores on certain indicators, one might wonder if the Zhejiang scale shows that businesses there are really strong (the province of Zhejiang actually has a very developed entrepreneurial fabric) or if the chosen indicators really measure what they want to measure.

The CCP may want to change the behavior of companies with good intentions (penalize those whose leaders cheat, for example) but Zhejiang results show perverse incentives. If the company is ranked higher by having ties to the Party and taking few risks, rather than having good financial health, is this really a good thing for the company?, its employees, and the Chinese economy more generally?

With the CSE, the Chinese government is doing with companies like Meta with its users around the world: collect data. There are, however, several significant differences.: in China it is done by the administration; and not for commercial purposes, but political. The credit system (and monitoring) is therefore much more than a simple rating agency. Reading the CSE experiments, the temptation of an authoritarian regime could be to try to change the thermometer to indicate that “all is well”. The actual temperature, elle, will remain the same...

Reference: Lin, L. Y. H., & Milhaupt, C. J. (2021), “China’s Corporate Social Credit System: The Dawn of Surveillance State Capitalism?”, The China Quarterly, 1-19.